How to Calculate the Equivalent Annual Percentage Rate (APR) of a Product
What is APR?
The APR of a financial product is the annual percentage rate that you will pay in interest on the amount you are borrowing, without even paying back any of the capital that you have borrowed. It is a useful figure to know on all sorts of loans that you might take out including personal loans, credit cards, mortgages or bonds and store cards.
For example if you have a product that has an APR of 10% then this means that for every £100 you borrow (I am using pounds but you can substitute whichever currency you chose instead), you will have to pay back £10 a year in interest and you will still owe the £100 at the end of the year.
In some countries there is a lot of regulation on financial products and it is obligatory to show the equivalent APR which can often also include any upfront fees that you need to pay to take out the loan. However, in some countries (and I know that Dubai is one of them) there is no obligation to show the APR when quoting an interest rate to a potential customer and often the rate quoted is a monthly one. In fact I spoke to a representative of one international bank in Dubai and they did not even know what an APR was.
Why Would You Need To Calculate the APR?
In some instances you may only be told what the monthly interest rate is and this can sometimes be a bit deceiving in terms of what you think you might be paying annually. You cannot simply multiply this figure by 12 (unless the product is calculating interest on a simple rate rather than compound but this is unlikely and so i will not cover this here). You also might be quoted a monthly payment term on a loan according to how much you want to borrow and over how long a term that may be. In that case it can be useful to compare the APR on different terms or else on different payments.
How to Calculate the APR Based on a Monthly Interest Rate
If you are given a monthly interest rate by a lender then to convert it to an APR you need to do the following. Let’s say the monthly percentage rate is 2.15%.
- 2.15% expressed as a decimal is 0.0215.
- Add 1 to this number so you get 1.0215.
- Multiply this number by the power of 12 – you can do this in excel by typing the following formula: +1.0215^12 – this gives an answer of 1.290804. From this deduct the 1 to give 0.290804 then multiply by 100, giving 29.0804 or 29.1% rounded. This is your APR.
How to Calculate the APR Based on a Monthly Payment
If you have been quoted a monthly payment but don’t know what this works out as in terms of the APR then this is a little more complicated and you will need to use excel. In this case I am assuming that the payment you make each month is interest + capital so that at the end of the term stated you will have paid off the loan. So, for example, you are taking out a loan of 10,000 (doesn’t matter which currency) and you have been told that the monthly payments are going to be 210 over a period of 5 years (60 monthly payments). In short the formula you need to enter in excel is as follows:
This give you the result 1.12% which is the monthly rate – you can then use the formula in the above section to calculate the annual rate which equates to 14.3% APR.
This is a very generalised example of how to calculate the APR and does not take account of any special circumstances but just enables you to understand the maths behind the calculation so that you can make educated decisions. However, it is no substitute for targeted financial advice which you are encouraged to seek if you are in any way confused or need more information on this subject.